Cash Flow Forecasts

Learn about cash flow fundamentals, inflows/receipts, outflows/payments, planning, monitoring, and cash flow statements. Discover the importance and benefits of cash flow forecasts in business management.

• cash flow
• business finances
• forecasting
• planning
• management

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1. E1 CASHFLOW FORECASTS CASH FLOW FORECASTS

2. CASH FLOW FORECASTS In this topic you will learn about Inflows/receipts Cash sales Credit sales Loans Capital introduced Sale of assets Bank interest received Outflow/payments Cash purchases Credit purchases Rent Rates Salaries Wages Utilities Purchase of assets Value Added Tax (VAT) Bank interest paid Prepare, complete, analyse, revise and evaluate cash flow Use of cash flow forecasts for planning, monitoring, control, target setting Benefits and limitations of cash flow forecasts

3. THE NATURE OF CASH FLOW Cash flows into AND out of a business Cash sales Payments from debtors Owners capital invested Sale of assets Bank loan Purchasing stock Paying wages Paying debts bank loans, creditors Purchasing assets Cash flow is interested in the balance between these cash inflows and cash outflows in terms if their relative size and timings.

4. CASH FLOW FORECASTS Cash flow is important to a business as it needs to ensure a positive cash balance in order to be able to meet day to day expenses A cash flow forecast is a forward looking statement that tries to predict cash inflows and outflows in the future Cash flow forecasts are an important part of a business plan A cash flow statement is a backward looking statement that shows what happened to cash inflows and outflows Cash flow statements are normally presented as a part of a business accounts A potentially profitable business may fail because it has cash flow problems Before looking at this link try to list up to 11 common reasons why small businesses fail. At which number are you going to put running out of cash?

5. CASH FLOW FORECASTS You have already covered all of these terms. Cash inflows/receipts Money flowing into the business: Write a sentence for each term explaining how it allows cash to flow into a business. Cash sales Credit sales Loans Capital introduced Sale of assets Bank interest received

6. CASH FLOW FORECASTS You have already covered all of these terms. Cash outflows/payments Money flowing out of the business: Write a sentence for each term explaining how it involves cash flowing out of a business. Cash purchases Credit purchases Rent Rates Salaries Wages Utilities Purchase of assets Bank interest paid

7. CASH FLOW FORECASTS Cash outflows/payments One more cash outflow is value added tax (VAT) Taxes are charges made by the government VAT is charged on a large number of goods and services The current rate (2016) is 20% If a business has annual revenue in excess of 83 000 (2016) it must become VAT registered It will then charge 20% VAT on all goods and services It can however reclaim VAT paid on goods and services Numerical example: Company A makes 36 000 in sales, in a 3 month period, of which 6 000 is VAT. In the same 3 months it pays 2 000 in VAT on goods and services purchased. Company A owes HMCR 4 000 ( 6 000 - 2 000).

8. PREPARE A CASH FLOW FORECAST Forecast cash inflows Owner s investment or other source of finance Cash sales estimated from sales forecast may be over or under estimated to some extent depends upon the scale of research More difficult for new businesses What is expertise of entrepreneur? How have estimates been calculated? Is it a new product or service? How might competitors react? Debtor payments estimated from sales forecast Determined by credit terms offered to customers Will debts be paid on time? How good is a firm s credit control?

9. PREPARE A CASH FLOW FORECAST Forecast cash outflows Payment of fixed costs These should be easy to estimate on a month by month basis Time delay between estimates and signing contracts can cause inaccuracies Payment of variable costs If sales are difficult to forecast so are the costs associated with meeting demand Made more difficult if suppliers are free to change the prices charged Unforeseen expenses One off payments that were not expected or expenses that have not been planned for Payment terms What if a supplier changes terms and wants payment sooner or a lender demands their money back? Unforeseen expenses can have a major impact on cash flow!

10. COMPLETE A CASH FLOW FORECAST Cash inflows shows: Cash in from sales Cash sales appear in the month of sale Credit sales (receivables)appear in month of cash receipt Cash from other sources e.g. loan, investment Cash outflows shows: Cash out for purchases and payments Cash payments appear in month of purchase Credit payments (payables) appear in month of cash outflow E.g. phone usage line rental paid each month, call charges every 3 months Write a definition of receivables and payables.

11. COMPLETE A CASH FLOW FORECAST Net cash flow The net result of cash inflows and cash outflows each month Net cash flow = cash inflows cash outflows Opening balance How much the business has at the start of each month For a new business in month 1 this will be 0 The closing balance for one month becomes the opening balance for the next Closing balance How much the business has at the end of each month Calculated as: Opening balance + net cash flow

12. COMPLETE A CASH FLOW FORECAST Jan Feb Mar Apr Cash inflows 5000 0 0 0 Owner s capital 1600 2000 2500 2500 Cash sales Credit sales 0 400 500 500 Total inflows 6600 2400 3000 3000 Cash outflows Rent & rates 700 700 700 700 Materials 2800 800 1000 800 Wages & salaries 1000 1000 1000 1000 Other expenses 450 450 450 450 Total outflows 4950 2950 3150 2950 Net cash flow 1650 (550) (150) 50 Opening balance 0 1650 1100 950 Closing balance 1650 1100 950 1000

13. ANALYSE CASH FLOW FORECASTS Timings of cash inflows Why might a business be willing to offer a customer long payment terms? If cash inflows are slow this may cause cash flow problems A firm may try to speed up cash inflows This may include offering a discount for early payment or penalties for late payments Businesses may need to chase customers for payment i.e. credit control When a business is owed money from customers these are referred to as receivables The business is still to receive the payment

14. ANALYSE CASH FLOW FORECASTS Timings of cash outflows What are the potential disadvantages to a business of asking for a longer period to pay? If cash outflows are too quick this may cause cash flow problems A firm may try to slow down cash outflows This may include negotiating longer payment terms from suppliers When a business owes money to suppliers these are referred to as payables The business is still to make the payment What are the costs and benefits to Tesco of delaying payments to suppliers? What is the likely consequence of this to their suppliers??

15. ANALYSE CASH FLOW FORECASTS Cash flow problems Businesses need to have sufficient cash to meet day to day finances Buying inventory Paying wages Utility bills Insufficient liquid cash funds may mean an inability to meet short term debts Bank overdraft Trade payables Limited cash may result in missed opportunities A key consideration should be whether the cash flow problem is short term or long term A firm may be able to survive short term cash flow problems Long term cash flow problems may be insurmountable

16. ANALYSE CASH FLOW FORECASTS Causes of cash flow problems: Credit sales Long payment terms Poor credit control Overtrading Additional overhead and day to day expenses Increased capital expenditure Internal management Stock control Relationship with suppliers Poor or inaccurate planning Seasonality Unexpected events What were the causes of the cash flow problems at Newport? Could Newport have done anything to avoid these problems?

17. IMPROVING CASH FLOW Increasing the volume of the inflow of cash Reducing the volume of the outflow of cash Speeding up the timing of the inflow of cash Slowing down the timing of the outflow of cash Inflows Outflows Capital invested Loan repayments Loans Day to day running expenses Cash sales Debtor payments Interest payments

18. IMPROVING CASH FLOW - INFLOWS Using financial institutions i.e. banks Overdraft an arrangement with the bank allowing the business to withdraw money above the amount available Provides some financial peace of mind Backed by a cash flow forecast to show ability to repay Allows flexibility Incurs interest and possible arrangement fee Can be ordered to repay immediately Short term loan an arrangement with a bank to lend money for a set period of time Pre agreed repayment terms Incorporated into budget and cash flow Interest rate may be lower than an overdraft Interest is paid on the total value of the loan May need to be backed by collateral

19. IMPROVING CASH FLOW - INFLOWS Debt factoring Debt factoring the process of selling a business debts i.e. the money owed to it, to a factor house at a reduced amount in order to receive immediate payment Immediate payment of debt Read what RBS says about factoring. Reduced risk of non payment (bad debt) Factor house takes a % as their profit You studied debt factoring in topic D1 as an external source of finance. How many other external sources of finance can you list? May alter customer s image of business

20. IMPROVING CASH FLOW - INFLOWS Cash payments from customers Reducing credit terms credit terms refers to the amount of time a customer is given to pay for their goods and services Some businesses offer customers a discount for immediate or quick payment Quick cash inflow Reduced risk of bad debt May need to offer a discount May lose customers Credit control the process of chasing payments from debtors (people who have bought from you on credit) Brings cash into the business Full amount received May alienate customers Administratively demanding Should businesses enrol the help of experts in credit control?

21. IMPROVING CASH FLOW - OUTFLOWS Delaying payment to suppliers Negotiating longer payment terms May incur penalties Need to maintain positive relationship Stock management Reducing money tied up in stock Need reliable stock deliveries Reduce overhead spending Cut unnecessary expenditure Should not have negative impact on productivity Consider any knock on effect on sales

22. DIFFICULTIES IMPROVING CASH FLOW Damage to the firm s reputation Potential loss of customers if payment terms affect competiveness Administrative costs and time Loss of discounts or need to offer discounts May affect profitability e.g. only receive part of debt or more expensive to lease assets in the longer run

23. IN PAIRS Method of improving cash flow Potential difficulties of improving cash flow Overdraft Short term bank loan Debt factoring Sale of assets Sale and leaseback Cash payments from customers Credit control Delay payment to suppliers Stock management Reduce overhead spending

24. ACTIVITY DAVES DIRECT DELIVERIES Dave started his courier business 3D Ltd 5 years ago. It currently operates with a fleet of 8 trucks and 2 bikes. Over the past year however things have got tough; rising fuel prices, increased road tax and falling customer numbers have meant he has had to reduce his drivers from 8 to 5, all of whom are paid on a weekly basis. Dave already has a bank loan for 50 000, the repayment on which has also gone up recently due to a rise in interest rates. Last month two of his regular customers cancelled their contracts, one of whom still owes him 6 000. Both explained that they were moving to cheaper competitors who offered 45 day payment terms compared to Dave s 30 days. Dave s wife Doris helps out on a part time basis in the office where she answers the phone, sends invoices and keeps the financial records of payments and expenditure. Dave is worried, his bank balance is nearly zero and if things don t improve in the next 3 months he is anxious he will have serious cash flow problems and not be able to meet his day to day running costs. Identify the possible steps Dave could take to help solve his cash flow problem. For each step identify an argument for and against taking that step. Recommend 3 proposals to Dave. You should prioritise and justify your proposed solutions. 1) 2) 3)

25. THE USE OF CASH FLOW FORECASTS Discuss how cash flow forecasts can be used for: Planning Monitoring Control Target setting To identify the timing and significance of any potential shortfalls To identify possible corrective action To help secure finance from potential investors or the bank To give confidence about short term survival To provide a guide against which to measure actual cash flow

26. DIFFICULTIES IMPROVING CASH FLOW Damage to the firm s reputation Potential loss of customers if payment terms affect competiveness Administrative costs and time Loss of discounts or need to offer discounts May affect profitability e.g. only receive part of debt or more expensive to lease assets in the longer run

27. IN PAIRS Method of improving cash flow Potential difficulties of improving cash flow Overdraft Short term bank loan Factoring Sale of assets Sale and leaseback Cash payments from customers Credit control Delay payment to suppliers Stock management Reduce overhead spending

28. BENEFITS AND LIMITATIONS Benefits Limitations Identify potential problems before they arise planning Identify opportunities for the use of excess cash Control spending Help to raise finance Negotiate trade credit Plan to meet day to day expenses Where necessary take corrective action Set cash flow targets Needs to be monitored and reviewed Based on forecasts and therefore maybe (is likely to be) inaccurate Does not ensure survival May lose customers if too concerned about the timings of cash inflows May increase costs if too concerned about the timings of cash outflows

29. CASH FLOW FORECASTS In this topic you have learnt about Inflows/receipts Cash sales Credit sales Loans Capital introduced Sale of assets Bank interest received Outflow/payments Cash purchases Credit purchases Rent Rates Salaries Wages Utilities Purchase of assets Value Added Tax (VAT) Bank interest paid Prepare, complete, analyse, revise and evaluate cash flow Use of cash flow forecasts for planning, monitoring, control, target setting Benefits and limitations of cash flow forecasts